Summary of the Sec. 409A correction program.

• Author: Adkins, G. Edgar, Jr.

Sec. 409A imposes restrictions on the operation of nonqualified deferred compensation plans. Sec. 409A and the corresponding regulations are extremely complex. The definition of deferred compensation is very broad, causing Sec. 409A to apply to a wide variety of compensation arrangements extending well beyond traditional deferred compensation plans and including arrangements with rank-and-file employees as well as executives.

Compliance with Sec. 409A requires a great deal of attention to detail. It is unlikely that an arrangement can comply with Sec. 409A without the establishment of, and perfect adherence to, flawless administrative procedures. Despite the detailed regulations and other guidance that the IRS has issued, new questions continually arise as to the proper application of Sec. 409A to various types of nonqualified deferred compensation arrangements.

Given the complexity of Sec. 409A, it seems inevitable that taxpayers will make mistakes as they attempt to comply with it. Fortunately, the IRS has established a correction program for certain violations of the Sec. 409A rules. This program, which is set forth in Notice 2007-100, provides for the self-correction of certain unintentional operational errors without any penalties if the errors are corrected within the same tax year of the service provider in which the errors occur. (The term "service provider" refers to individuals who are providing services, such as employees, independent contractors, or board members.)

For certain errors that are not corrected by the end of the tax year in which the error occurs, the program permits self-correction with limited penalties as long as the amount involved in the error is below a prescribed threshold and the error is corrected by the end of the service provider's second tax year following the tax year in which the error occurred. The self-correction program for the latter category of errors generally is available only for errors that occur in a tax year beginning before January 1, 2010. (The IRS intends to establish a permanent correction program but has not yet done so.) The program does not provide for self-correction for any errors that are corrected later than two tax years following the end of the service provider's tax year in which the error occurred. This article summarizes the self-correction program.

General Rules

Benefits of the Sec. 409A Correction Program

* No Sec. 409A penalties for certain errors corrected within the same tax year in which the error occurs, regardless of the amount involved.

* Limited Sec. 409A penalties for certain errors that are not corrected within the same tax year in which the error occurs but are corrected by the end of the employee's second tax year following the tax year in which the error occurred, and when the amount involved is equal to or less than the limit on elective deferrals to qualified plans ($15,500 or less in 2007 or 2008, as indexed for inflation).

Errors That Cannot Be Corrected Under the Program

* Exercise of a stock option or stock appreciation right that results in a failure to comply with Sec. 409A.

* Intentional errors.

* Egregious errors.

* Errors directly...